What is a trust account and why is it needed?

It wouldn’t be a surprise if you had never heard of a “trust account” prior to partaking in a divorce. While there are many different types of trust accounts, in this context we will discuss accounts that attorneys, specifically family law attorneys, maintain on behalf of their clients.

To begin, a trust account is a separate account that a lawyer or law firm may open to hold money that a client or third party has an interest in. Attorneys are not allowed to comingle (mix) any of their own personal funds with funds held in a client’s trust account (with some limited exceptions). There are two types of attorney-client trust accounts. The first is an “IOLTA” account, which holds small amounts of money for short amounts of time, typically retainers, and the interest accrued goes to the state bar. The second type is a Segregated Interest-Bearing Attorney Client Trust Account (“segregated trust account”), which holds larger amounts of money for longer periods of time, and the interest accrued goes to the client. The second type, segregated trust accounts, will be discussed here.

One very common use for segregated trust accounts in divorces is to hold the proceeds from the sale of a marital residence. Often times, parties will agree to put their home for sale while their divorce is pending. However, until a divorce is finalized, it is not always clear exactly how much each party is entitled to from the marital estate. Often times, the home is the largest asset that parties own. In the broader picture of property division, many couples will have both separate property and community property, as well as certain rights to reimbursements, etc., which means that not everything you own will get divided exactly in half once you get a divorce.

Many divorcing couples, once their home is sold, will instinctively want to take the net proceeds and divide them equally among themselves. This is not always a good idea, and this is where the segregated trust account can play a very important role in the overall property division. To demonstrate, consider this scenario:

Husband and Wife buy a home during marriage. During marriage, Wife inherited some money from her deceased father. The couple then completes a $100,000 complete remodel of the home using the Wife’s inheritance money, which is her separate property. The home has $200,000 of equity at the time Husband and Wife separate. After separation, Husband argues that they used community property, not Wife’s separate property money for the remodel. Wife maintains that the remodel was done with her separate property and that she is entitled to a credit for whatever separate property money she put into the house. The house is sold before the divorce is finalized and before the parties are able to agree (or a court can rule) on whether community or separate property was used for the remodel. Wife will have to trace all of her separate property funds that went into the home.

Under Husband’s argument, each party should receive $100,000 from the division of the home’s sale proceeds. Under Wife’s argument, she should receive $100,000 “off the top” for her separate property contribution to the home, and then they should each receive $50,000 for the community property equity in the residence (in other words, Wife receives $150,000 and Husband receives $50,000). It should be clear that the funds received from the sale of the house shouldn’t be divided between the parties until this dispute has been resolved. A concern, for example, would be that if Husband received $100,000 when he was only entitled to $50,000, but by the time the divorce was finalized he already went out and spent the $100,000 (on a new house perhaps), and if that was the only substantial asset of the parties, Wife would have one heck of a time getting the money back to her later.

Using a segregated trust account in this situation can resolve this and other potential problems regarding the funds until the issues of property division have been resolved. It can also offer some flexibility to the parties even if funds are needed immediately. For example, the trust account can hold all $200,000 until all the other property division is worked out and an equalization payment is determined. Or, if the home is the only significant asset of the parties, they can agree (or ask the court if they can’t agree) to distribute a portion of the funds, to help with living expenses while the divorce proceeds, and have the remainder held in trust until the final property division is agreed upon by the parties or ordered by a judge.

Feel free to contact us if you are considering a divorce from your spouse, a legal separation, or have questions regarding property division and trust accounts. Nancy J. Bickford is the only Certified Family Law Specialist (CFLS) in San Diego County who is also a licensed Certified Public Accountant (CPA) with a Master of Business Administration (MBA). Don’t settle for less when determining your rights. Call 858-793-8884 in Del Mar, Carmel Valley, North County or San Diego.